China's Bank Insurance Plan Is Set to Crimp Profits, Fuel M&A

Premiums Weigh on Profits

After more than two decades of deliberation, China will start an insurance system for its more than 100 trillion yuan ($16.1 trillion) of bank deposits on May 1. Here are some of the implications.

1. Curbs on Deposit Rates Will Be Lifted Soon

China’s interest-rate liberalization can be traced back to 1993, when the Communist Party drafted a market-oriented reform blueprint. Deposit insurance to protect savers was among the government’s requirements for fully deregulating rates. While banks are currently limited to paying 30 percent more than a benchmark deposit rate, central bank Governor Zhou Xiaochuan said March 12 that the cap is very likely to go this year.

“It would not be realistic to move to market-set deposit rates without the insurance in place,” said Jim Antos, a Hong Kong-based analyst at Mizuho Securities Asia Ltd., adding that without such a measure money would flee to banks seen as stronger from those perceived as weaker.

2. Smaller Banks May Come Under Pressure

By setting an insured limit of 500,000 yuan per account, the system will cover the deposits of 99.63 percent of savers, according to the government.

Yet, that represents only an estimated 50 percent of total deposits, according to Shenyin & Wanguo Securities Co., meaning that people or companies with larger amounts may spread their money around, probably choosing a mix of the bigger banks, which have higher credit ratings, analysts led by Chen Kang wrote in a note Wednesday.

Smaller banks may also lose out as they will need to pay higher deposit insurance premiums because they are riskier, Ping An Securities Co. analyst Li Yamin wrote Wednesday. Li assumed that the largest banks may need to pay the equivalent of 0.05 percent of their deposits as a premium, mid-sized national banks 0.08 percent, and small city commercial banks 0.1 percent. The net result: a 2.3 percent reduction in annual profit for the smallest banks, versus a 1.1 percent slide for the biggest.

Mergers and acquisitions will be inevitable over the next decade, Li said.

3. Borrowing Costs May Rise as Banks Compete for Deposits

The moves to intensify competition between lenders may lead to higher interest rates as banks pay more for deposits and pass on the extra cost to borrowers.

“Competition among banks would almost certainly cause deposit rates to rise closer in line with market rates -- we think a one percentage-point increase in average deposit rates is plausible,” Capital Economics Ltd. economists Julian Evans-Pritchard and Chang Liu estimated Tuesday. While banks’ net interest margins would suffer, most are highly profitable and should cope, they said.

Goldman Sachs Group Inc. analysts say removing the deposit-rate ceiling may lead to higher interbank rates, a tightening that the central bank would need to counter.

4. Central Bank Will Keep Intervening and May Loosen

Giving markets a bigger role through interest-rate deregulation doesn’t mean that officials stop intervening by putting pressure on some lenders to set their rates where the government wants them. While the central bank has raised the maximum deposit rates allowed, most recently on March 1, officials have also instructed some individual lenders to reduce rates from such levels, people with knowledge of the matter said last month.

A rate cut or “liquidity easing” could take place around the start of the insurance system “to smooth the transition process,” according to Qu Hongbin, an HSBC Holdings Plc economist in Hong Kong.

At Huachuang Securities Co., Beijing-based analyst Qu Qing says Chinese banks may need to pay 20 billion yuan to 40 billion yuan of deposit insurance per year based on typical global rates of between 0.05 percent and 0.1 percent of deposits.

5. More Private Banks Will Set Up Shop

Levelling the playing field via deposit insurance may encourage more private banks to set up after the authorities approved five in 2014. The banking regulator may give the go ahead for 30 more this year, Chinese business magazine Caixin reported last month.

6. A Chinese Bank Will Fail... Eventually

The failure of Hainan Development Bank in 1998 was an exception to the rule that the Chinese government won’t let lenders go under. While adding protection for savers raises the prospect of allowing bank failures, some analysts are sceptical that such bankruptcies will happen any time soon. Yao Wei, a Paris-based China economist at Societe Generale SA, said Tuesday that such failures seemed a distant prospect in a financial system where it was unusual for a bond or a trust investment product to default.

— With assistance by Jun Luo

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